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July 1, 2014, Class Action Law Reporter

Courtney L. Davenport

Despite the defense bar’s comments to the contrary, plaintiff attorneys consider the Supreme Court’s recent ruling in Halliburton Co. v. Erica P. John Fund, Inc., to be a significant victory for investors because the Court not only declined to overrule the fraud-on-the-market doctrine but also said defendants must prove there was no price impact.

Despite the defense bar’s comments to the contrary, plaintiff attorneys consider the Supreme Court’s recent ruling in Halliburton Co. v. Erica P. John Fund, Inc., to be a significant victory for investors because the Court not only declined to overrule the fraud-on-the-market doctrine but also said defendants must prove there was no price impact.

“We are pleased that the United States Supreme Court has rejected Halliburton’s radical suggestion that the Court overrule 26 years of precedent to essentially grant corporations a license to commit securities fraud, and instead preserved the rights of investors to hold corporations accountable,” said AAJ President Burton LeBlanc in a statement.

In 1988, the Court opened the door to securities fraud class actions when it held in Basic Inc. v. Levinson (485 S. Ct. 224 (1988)) that investors need not prove direct reliance on a material misrepresentation to satisfy Rule 23’s predominance requirement. Instead, there is a rebuttable presumption of classwide reliance if the alleged misrepresentations were public, material, and involved securities traded in an efficient market, because courts must assume the statements are reflected in the alleged artificial price.

Without this fraud-on-the-market doctrine, many securities fraud cases would be impossible to bring. That’s why corporations and the defense bar have fought against it so vigorously. The Court has steadfastly held to the doctrine: In 2011, when Halliburton first went before the Court, it reversed the lower courts’ denial of certification, holding that plaintiffs need not prove loss causation to invoke the doctrine. (131 S. Ct. 2179 (2011).) Last year, it reaffirmed Basic, holding in Amgen v. Connecticut Retirement Plans and Trust Funds(133 S. Ct. 1184 (2013)) that plaintiffs also do not have to prove materiality until the merits stage. But a dissent by Justices Anthony Kennedy, Antonin Scalia, and Clarence Thomas gave corporations new hope by mentioning in a footnote that Basic might no longer be valid.

In the meantime, the lower court had certified the Halliburton class. On appeal, Halliburton seized on Amgen’s footnote to argue—for the first time—that Basic should be overturned or, alternatively, that plaintiffs should be required to prove price impact to invoke fraud on the market. The Fifth Circuit affirmed certification, but the Court granted certiorari to finally decide whether Basic is still good law. At oral argument, several justices expressed reluctance to overturn Basic but seemed to be considering what Kennedy called a “midway position,” which would require plaintiffs to prove price impact at certification. That burden could cripple plaintiffs because they would have to commission event studies much more complicated and expensive than those needed to show market efficiency.

In its decision, however, the majority—led by Chief Justice John Roberts and joined by Kennedy and Justices Ruth Bader Ginsburg, Stephen Breyer, Sonia Sotomayor, and Elena Kagan—refused to overrule Basic or require that plaintiffs prove price impact for a reliance presumption. Although the defense bar and corporations have claimed victory because the Court ruled defendants are allowed to rebut the presumption with price-impact evidence, New York City attorney Salvadore Graziano, who has brought many securities class actions, said the real-world significance of that is slight.

“I don’t see it having much impact at all,” he said. “It’s the rare case where a defendant can rebut it at certification, because the case most likely wouldn’t survive a motion to dismiss, let alone get to certification, if there’s no price impact whatsoever.”

He noted that Ginsburg, Breyer, and Sotomayor wrote a concurrence specifying that although the ruling “may broaden the scope of discovery available at certification . . . the Court recognizes that it is incumbent upon the defendant to show the absence of price impact . . . The Court’s judgment, therefore, should impose no heavy toll on securities-fraud plaintiffs with tenable claims.”

The Court went further than many plaintiff attorneys expected because it loosened the concept of an efficient market. The Court reinforced that Basic did not envision that all markets were efficient or all investors relied on efficiency—contradicting Halliburton’s assertion that Basic made efficiency a binary yes-or-no question not grounded in economic reality. Instead, Basic accepted that exceptions would arise, and that’s what the rebuttal process is for. Basic’s presumption is based on “the fairly modest premise” that most investors consider public statements and rely on the price as an unbiased assessment of the security’s value, the Court said.

The Court also specified that although Basic is a judicial, not legislative, construct, it is still substantive law.

“By reaffirming that the fraud-on-the-market presumption is ‘a substantive doctrine of federal securities-fraud law,’ Halliburton has assured the continuing importance of class actions in deterring and remedying securities fraud,” said securities attorney William Norton of Mt. Pleasant, S.C. “As such, the Court’s ruling is a positive outcome for investors.”

Although Thomas, Scalia, and Justice Samuel Alito concurred that the case should be remanded to give Halliburton a chance to rebut the presumption with price-impact evidence, their agreement stopped there. They wanted to overturn Basic, arguing its “reimagined reliance requirement was a mistake” based on “a questionable understanding of disputed economic theory and flawed intuitions about investor behavior.”

They also claimed Basic is at odds with the Court’s stringent Rule 23 requirements in Wal-Mart Stores, Inc. v. Dukes and Comcast Corp. v. Behrend. But the majority rejected the comparison. Those cases held that plaintiffs must prove—not merely plead—each Rule 23 requirement, including predominance. Halliburton argued Basic relieves securities-fraud plaintiffs of that burden. Basic does not relieve the burden, the majority said; rather, it tells plaintiffs what they must prove to show predominance.

“The decision was supposed to be the death knell of securities class actions, so it is remarkable for it being kind of a non-event,” said Graziano. “This is a very strong win. It’s hard to see how we could have done any better.”